The danger of overconfidence when it comes to investing!


Did you know that almost 90% of all drivers think that they are better than average (Swedish Psychology Journal, Acta Psychologica, Aug 24, 2011). A similar figure applies to the anticipated success of new business start-ups. Nearly everyone thinks they have an above average sense of humour too, and virtually all amateur golfers think they are actually better than their handicap suggests (this one could be true J). Even individuals who assert that they are 100% sure of a particular fact are usually wrong at least 20% of the time!
With this in mind then, is it surprising that over confidence can sometimes lead people to be unrealistically optimistic even in matters of high importance? Men – young men in particular – tend to be more optimistic than women and when it comes to investments, men, being more confident about their knowledge and investment expertise, tend to trade more but ultimately achieve inferior results than those who are more rounded and adopt a longer-term buy and hold strategy. Another negative consequence of this over confidence is that men tend to under-diversify. Believing that their hunch is right, they see no reason to spread the risk, leaving themselves unnecessarily open to losses.
According to an oft-cited study by Brad Barber and Terrance Odean, men trade 45% more than their female counterparts but earn annual net returns of 1.4% less. For single men versus single women, it’s even worse at 2.3% less. The authors cite increased trading costs, taxes, and a greater tendency to speculate as reasons for this under-performance.
Over-confidence however, is not the exclusive preserve of young men; we’re all prone to it, in fact. We routinely overestimate our depth of knowledge and ability to predict future investment outcomes. What’s more surprising though, is that declared experts and scholars, most of whom would be aware of this bias, suffer likewise.
This overly confident behaviour stems from believing that short term wins or successes are due to our own “superior knowledge” and “skill” rather than any kind of randomness. Making financial decisions based on such an uninformed attitude can quite often prove very costly, particularly to individual investors who are more vulnerable. Why? Because generally, they are not armed with the necessary information, unlike professional advisers and institutional sized investors who analyse the entire market and logically spread the risk across a much wider range of asset classes.
In Ireland, overconfident behaviour was extremely prevalent during the heady days of the Celtic Tiger. For a full decade or more prior to the downturn in 2007/2008, every other person was either a landlord or a property developer (or if not, aspired to be). And sure, why wouldn’t they, wasn’t it easy money? There were however, a number of behavioural biases at play, with people believing they were making money from good judgement rather than simply from a rising market. Common sense went completely out the window. Warren Buffet’s put it aptly when he said “a rising tide lifts all boats but it’s not until the tide goes out that we see who cannot swim”. Far too many as it turned out, couldn’t, and didn’t have a life jacket either.
Availing of the services and guidance of a Certified Financial Planner should certainly steer you clear of this over-exuberance and help you make better, more informed decisions about your investments.

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Paul is the Managing Director of Lifestyle Financial Planners Ltd, has been in business since 1985 and offers specialist, tax efficient wealth management, retirement and estate planning solutions to our customers. Paul is a Certified Financial Planner and holds a Masters Degree from UCD in Financial Services and Risk Management.
Tel; 096-75951 Mob; 086-8053755, Email; paul@lifestylefinancialplanners.ie web; www.lifestylefinancialplanners.ie
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Waiver: The information contained in this article is for general information only and cannot be relied upon as the basis for any form of agreement or advice. The author recommends that you seek independent tax, legal or financial advice relevant to your own particular circumstances.

Posted April 17th 2017

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